Homework 4 Bereket Desalegn Abebe F17401107

1. How is the future value of a single cash flow computed?

Future value (FV) is the amount due to be returned at a certain investment period from single cash flow
with annual compounding of interest.

To calculate the future value from single cash flow the step is

FV=C0 x (1+r)T

Where

FV- Future value

C0- Cash flow today
r- Appropriate interest rate
T- The number of periods over which the cash is invested
2. How is the present value of a series of cash flows computed?

The present value of a single cash flow refers to how much a single cash flow in the future would cost in
the current period.

To calculate the present value from single cash flow the step is

PV= C1

1+r

Where

PV- Present value

C1- Cash flow of date 1

r- Appropriate interest rate

3. What is the Net present value of an investment?

Net present value is the present value of the expected cash flow, less the cost of the investment.

To further elaborate, when investors invest they want to know how much they need in the present in
order to receive the cash flow (interest rate) in the future but we have to deduct the cost of investment
to get the scope of cash flow received and calculating the principal into the calculations.

4. What is an EAR, and how is it computed?

The Effective Annual Rate (EAR) is the interest rate that is adjusted for compounding over a given
period. Simply put, the effective annual interest rate is the rate of interest that an investor can earn (or
pay) in a year after taking into consideration compounding.

EAR = (1+I/n)^n -1
Where

EAR- Effective annual rate

I = stated annual interest rate

n = number of compounding periods

5. What is a perpetuity? An annuity?

A perpetuity is an annuity that has no end, or a stream of cash payments that continues forever.
There are few actual perpetuities in existence

An annuity is a series of payments made at equal intervals